Magazine article Management Today

PRP Plus Turns to Minus

Magazine article Management Today

PRP Plus Turns to Minus

Article excerpt

The withdrawal of tax exemption on profit-related pay has left participating employers and employees wondering who or what will plug the gap in wage packets.

'Profit-related pay is now firmly established as part of British businesses' pay policy. It is one of the reasons for our success. More than 3.7 million people are in schemes.... [The tax-exempt scheme] has successfully served its pump-priming purpose.'

Abolishing a scheme for being too successful and popular might seem an odd step for a politician, particularly in the run-up to a general election, but these were the reasons cited by the former chancellor, Kenneth Clarke, when he announced the phasing out of the tax exemption on profit-related pay (PRP) in November 1996.

Launched by Nigel (now Lord) Lawson in the 1987 budget, the government's PRP scheme was intended to strengthen the enterprise culture by allowing people lower down the hierarchy to benefit from company profits. The outgoing rules allow companies to pay up to 20% of salary - or [pounds]4,000 if lower - in the form of a tax-free bonus. In practice this means that a top-rate taxpayer gains up to [pounds]1,600, while someone on the basic rate might net as much as [pounds]960. 'The scheme really was phenomenally attractive,' laughs Ian Nichol, a partner at Coopers & Lybrand. 'In fact it was generous to a fault.'

Predictably, there was no shortage of companies interested in reaping the benefits of the government's munificence - for their employees and for themselves. In its first year, the scheme attracted 145 participants. Word spread among company secretaries and by the end of 1994/5, some 9,425 companies were taking advantage of its terms. A year later the figure was 12,700 and by the time the scheme's abolition was announced, the total was probably nearer to 14,000.

But the same generosity that made the scheme so popular is now causing a severe headache for participating companies. Quite who is going to make good the hole left in take-home pay by the withdrawal of tax exemption? If employers make good the shortfall, it could add over 8% to their wages bill. If, on the other hand, they fail to plug the gap, they may alienate some of their most capable staff whose pay will effectively be docked by hundreds or thousands of pounds a year.

For some employers, motivated to join the scheme purely by an altruistic desire to benefit their employees, the answer lies in examining other ways of making up the loss of tax exemption to their employees. But for others, the right course is less clear. These are the companies which were apparently drawn to PRP by the idea of cashing in on their staff's allowance, in effect using their employees' tax break to cut payroll costs. 'Some companies introduced PRP instead of a rise or to subsidise their wages bill,' explains David Ogden, share plans director at pay consultants Sedgwick Noble Lowndes. They achieved this by persuading staff to take a pay cut, or by not increasing pay when a rise was due, and then making good the difference with the tax-free bonus.

According to Cliff Weight of management consultants Hay, the influence of company accountants trying to improve the bottom line is apparent from the chronology of deals: 'Nearly all the early schemes were simply bonuses converted to PRP. These will all have stipulated that if the government removes the tax break, that's not the employer's fault.' He estimates that 60%-70% of later schemes are salary sacrifices, where employees take a pay cut which is replaced by PRP. In these cases employers often split the tax benefits with their employees, sometimes even going so far as to absorb the entire benefit.

All good things come to an end, however, and as the ebullient chancellor sipped his trademark tumbler of whisky, he announced that from 1997/8 the maximum tax-free allowance of [pounds]4,000 would fall to [pounds]2,000 in 1998, [pounds]1,000 in 1999 and disappear completely in the new millennium. …

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